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Causality between energy consumption and

economic growth in India: a note on


conflicting results
Shyamal Paul
a
, Rabindra N. Bhattacharya
b,
*
a
Khalisani Mahavidyalaya, Chandannagar-712138, W. B., India
b
Department of Economics, Kalyani University-741235, W. B., India
Available online 25 September 2004
Abstract
This note examines the different direction of causal relation between energy consumption and
economic growth in India. Applying EngleGranger cointegration approach combined with the
standard Granger causality test on Indian data for the period 19501996, we find that bi-directional
causality exists between energy consumption and economic growth. Further, we apply Johansen
multivariate cointegration technique on the different set of variables. The same direction of causality
exists between energy consumption and economic growth. This is different from the results obtained
in earlier studies.
D 2004 Elsevier B.V. All rights reserved.
JEL classification: Q
41
; Q
43
Keywords: Energy consumption; Economic growth; India; Granger causality; Cointegration
1. Introduction
All production and many consumption activities involve energy as an essential input. It
is the key source of economic growth, industrialization and urbanization. On the other
hand, economic growth, industrialization and urbanization may induce use of more energy,
0140-9883/$ - see front matter D 2004 Elsevier B.V. All rights reserved.
doi:10.1016/j.eneco.2004.07.002
* Corresponding author. Tel.: +91 33 2582 8750x288/289; fax: +91 33 2582 8282.
E-mail addresses: shyeco@yahoo.co.in (S. Paul)8 rnbeco@yahoo.com (R.N. Bhattacharya).
Energy Economics 26 (2004) 977983
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particularly commercial energy. India has been passing through an economic reform since
1991, the general aim of which is to quadruple its economic growth and remove the
problems of poverty and unemployment. One of the obstacles to achieve these objectives
has been the frequent occurrence of energy shortages in the economy. In India, commercial
energy consumption over time has grown at a compound annual growth rate (CAGR) of
about 6% which is more than the CAGR of GDP during the last two decades.
1
So the
relation between energy consumption and economic growth is of great interest to the
energy economists. It is not possible to achieve high growth in one, without keeping pace
with another.
The direction of causation between energy consumption and economic growth has
significant implications. If, for example, there exists unidirectional causality running
from economic growth to energy consumption, it may be implied that energy
conservation policies may be implemented with little adverse or no effects on
economic growth. On the other hand, if unidirectional causality runs from energy
consumption to income, reducing energy consumption could lead to fall in income.
The finding of no causality in either direction, the so-called dneutrality hypothesisT
would imply that energy conservation policies do not affect economic growth (Asafu-
Adjaye, 2000).
However, in India not much attention has been devoted to investigate the causal
relationship between economic growth and energy consumption. In some earlier studies
Pachuri (1977) and Tyner (1978) using regression approach have found a strong relation
between energy consumption and economic growth in India. Cheng (1999) in his quest for
causality has established a unidirectional causal relation from economic growth to energy
consumption. In contrast, Asafu-Adjaye (2000) has estimated a unidirectional Granger
causality from energy consumption to income. The finding of Asafu-Adjaye (2000) does
not support the finding of Cheng (1999). Our empirical result identifies bi-directional
causality between energy consumption and economic growth. The present analysis
attempts to discuss how our finding contrasts with the findings of Cheng (1999) and
Asafu-Adjaye (2000).
2. Empirical evidence
The empirical findings on the causal issue between energy consumption and economic
growth have been mixed or conflicting. The reason for the disparate and often conflicting
empirical findings lies in the variety of approaches of time frame considered and testing
procedures employed in the analysis.
Cheng (1999) has applied JohansenHsiaos version of the Granger causality
method on the Indian data for the time period 19521995. This study finds that energy
consumption, economic growth, capital and labour are cointegrated and the direction of
causality runs from economic growth to energy consumption both in the short-run and
1
It is worthwhile to note that past trend in energy consumption does not fully represent the growth of energy
demand. To a large extent it reflects the net availability (Bhattacharya and Paul, 2001).
S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 978
in the long run. No causal relation is found from energy consumption to economic
growth.
The modeling strategy adopted in Asafu-Adjaye (2000) is based on the Engle and
Granger (1987) methodology. He used three variablescommercial energy use, real
income and energy prices proxied by the consumer price index for the period 1973
1995 and found unidirectional Granger causality running from energy consumption to
economic growth both in the short run and in the long run. This discrepancy in results
between Cheng (1999) and Asafu-Adjaye (2000) may be due either to the choice of the
sample period or to the measure of the variables or to the choice of the methodology or
to both.
Now, based on our exercise, let us indicate the result of causality between energy
consumption and economic growth in India using a sample of annual data covering
the period 19501996. If a linear combination of the non-stationary variables is non-
stationary, then the Standard Granger causality test should be adopted. If a linear
combination of the non-stationary is stationary, then error-correction model (ECM)
should be adopted. We adopt the standard Grangers causality test (1969) when GDP
is treated as a dependent variable and then the error-correction model when energy
is considered as a dependent variable. Our combined results of the standard Granger
causality test and the EngleGranger error correction approach imply bi-directional
causal relation between energy consumption and economic growth. The Johansen
multivariate approach (1991) at lag length 3 reveals that the long-run causality exists
from economic growth to energy consumption and the short-run causality runs
from energy consumption to economic growth.
2
That is, a bi-directional causality
exists between energy consumption and economic growth (results are shown in
Appendix A).
The results of the standard Granger test and the EngleGranger approach show only
unidirectional causality between energy consumption and economic growth. But the
direction of causality in the approaches is different. In the EngleGranger model, the
long-run causality runs from economic growth to energy consumption and in the
standard Granger model, the causality runs from energy consumption to economic
growth. Use of Johansen multivariate approach reveals a short-run causality from energy
consumption to economic growth and the long-run causality from economic growth to
energy consumption. The interpretation of this short-run and long-run divergence in
causal relation between energy consumption and economic growth can be given as
follows.
In the short-run, energy, particularly commercial energy acts as an engine of economic
growth. It is a very important primary input in the aggregate production function. In the
context of a less developed country like India, the substitution of non-commercial energy
by commercial energy is likely to be limited in the short-run. But in the long run, with the
growth of income and technological progress, it is likely that more and more non-
commercial energy will be substituted by commercial energy.
2
The appropriate selection of lag will generate white noise residual process. Small lag misspecifies the model
and large lag indicates that the degrees of freedom are wasted (Hamilton, 1994).
S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 979
3. Discussion and conclusions
This note has demonstrated that the causal relation between energy consumption
and economic growth in India is mixed or conflicting. The results obtained from one
approach are found to be different from another. Our empirical results using the
standard Granger causality test reveal a unidirectional causal relation from energy
consumption to economic growth. This process does not show any causal effect from
economic growth to energy consumption. However, use of EngleGranger cointegra-
tion process exhibits a unidirectional long-run causality from GDP along with capital
to energy consumption. No short-run relation is found. The results of the Engle
Granger approach combined with the standard Granger causality process indicate that
there is bi-directional causality between energy consumption and economic growth.
The long-run causal relation runs from GDP to energy consumption and the short-run
causal relation runs from energy consumption to GDP. The same results are obtained
by using Johansen multivariate approach on the different combination of variables.
These results are at variance with the results obtained by Cheng (1999) and Asafu-
Adjaye (2000).
Acknowledgements
We are grateful to an anonymous Associate Editor of this journal for some helpful
comments on an earlier draft of this paper. However, usual disclaimer applies.
Appendix A
In the following tables variables used are named as E=commercial energy
consumption, G=national income of the Indian economy, F=gross fixed capital formation
of the economy and L=population, a proxy for labour. All variables are expressed in terms
of natural logarithm.
Table 1
Cointegration tests (EngleGranger procedure)
Regression equation:
Y
t
X
1t
X
2t
a b c q (statistics) n
G
t
C
t
F
t
6.08 0.45 0.38 0.35 (2.86) 1
E
t
G
t
F
t
7.50 0.69 0.43 0.53* (4.04) 1
F
t
E
t
G
t
0.21 0.53 0.62 0.61* (5.50) 1
(a) Absolute t-statistics are in the parentheses. The 5% critical value for the t-statistic is 3.79 for 50
observations; see Charemza and Deadman (1999), Table 2.
(b) The parameter n was chosen in such a way that there was no serial correlation in the residuals in Engle and
Granger (1987) two-step procedure of cointegration test.
(c) * denotes statistically significant.
S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 980
Table 3
Test statistics of temporal causality using ECM based on cointegrating regression of EngleGranger procedure
Controlled
variable
1st manipulated
variable
2nd manipulated
variable
FPE F-value Error-correction
(Ec
t 1
)
1st Regression equation
E(i=1) 2.100329103
E(i=1) F( j=1) G(m=1) 2.162463403 0.82
E(i=1) F( j=1) G(m=1) 2.234479603 0.48 0.36* (3.11)
2nd Regression equation
F(i=4) 1.569449103
F(i=4) G( j=1) E(m=1) 1.647142803 0.44
F(i=4) G( j=1) E(m=1) 1.728100003 0.08 0.55* (3.86)
(a) The figures in parentheses behind the variables are the optimal lag length. Other figures in parentheses are the
absolute t-statistics.
(b) * denotes statistically significant.
Table 4
Johansen ML Procedure
Null Alternative Statistics 95% Critical value
r=0 r=1 27.33 22.00
rV2 r=2 13.90 15.67
rV3 r=3 6.49 9.23
Cointegration LR test Statistics: three variables VAR.
I(1) Variables included: E, G, F; Lag ( P)=3.
(a) r denotes the number of cointegrating vectors.
(b) Statistics on the above table based on the Maximal Eigen value of the Stochastic matrix.
Table 2
Granger standard causality test
Controlled
variable
1st manipulated
variable
2nd manipulated
variable
FPE F-value
Economic growth equation
G(i=1) 6.05904904
G(i=1) E( j=2) 5.40954304 4.77 *
G(i=1) E( j=2) F(m=1) 5.66098404 0.31
Energy consumption equation
E(i=1) 2.56107403
E(i=1) G( j=1) 2.65269803 0.39
E(i=1) G( j=1) F(m=1) 2.74081303 0.002
(a) The figures in parentheses behind the variables are the optimal lag length. Other figures in parentheses are the
absolute t-statistics.
(b) * denotes statistically significant.
S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 981
Table 6
Vector Error-Correction (VEC) model
Equation no. Dependent
variable
Independent variable ( F-statistics) Error-correction term (t-statistics)
DE
t i
DG
tj
DF
tm
Ec
t
1 DE
t
... 0.31 (0.74) 1.65 (0.21) 3.28* (0.00)
2 DG
t
4.75* (0.02) ... 1.03 (0.37) 0.01 (0.19)
(a) P-values are in the parentheses.
b) * denotes statistically significant.
Table 7
Johansen ML Procedure
Null Alternative Statistics 95% Critical value
r=0 r=1 33.02 28.14
rV2 r=2 19.16 22.00
rV3 r=3 9.39 15.67
rV4 r=4 5.23 9.24
Cointegration LR test Statistics: four variables VAR.
I(1) Variables included: E, G, F, L; Lag ( P)=3.
(a) r denotes the number of cointegrating vectors.
(b) Statistics on the above table based on the Maximal Eigen value of the Stochastic matrix.
Table 8
Johansen ML Procedure
Null Alternative Statistics 95% Critical value
r=0 r=1 66.79 53.12
rV2 r=2 33.78 34.91
rV3 r=3 14.62 19.96
rV4 r=4 5.23 9.24
Cointegration LR test Statistics: four variables VAR.
I(1) Variables included: E, G, F, L; Lag ( P)=3.
(a) r denotes the number of cointegrating vectors.
(b) Statistics on the above table based on the Trace of the Stochastic matrix.
Table 5
Johansen ML Procedure
Null Alternative Statistics 95% Critical value
r=0 r=1 47.72 34.91
rV2 r=2 20.39 19.96
rV3 r=3 6.49 9.23
Cointegration LR test Statistics: three variables VAR.
I(1) Variables included: E, G, F; Lag ( P)=3.
(a) r denotes the number of cointegrating vectors.
(b) Statistics on the above table based on the Trace of the Stochastic matrix.
S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 982
References
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series evidence from Asian developing countries. Energy Economics 22, 615625.
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Table 9
Vector Error-Correction (VEC) model
Equation
no.
Dependent
variable
Independent variable ( F-statistics) Error-correction term (t-statistics)
DE
ti
DG
tj
DF
tm
DL
tn
Ec
t
1 DE
t
... 1.19 (0.32) 0.67 (0.52) 0.61 (0.55) 2.80* (0.00)
2 DG
t
4.50* (0.02) ... 1.14 (0.33) 0.21 (0.81) 1.35 (0.19)
(a) P-values are in the parentheses.
(b) * denotes statistically significant.
S. Paul, R.N. Bhattacharya / Energy Economics 26 (2004) 977983 983